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Posts Tagged ‘china’

China is being accused of starting a new currency war. The People’s Bank of China has devalued the Chinese currency three times in three days. Politicians on Capitol Hill can barely conceal their ire. There is even talk that both the Fed and Bank of England will hike interest rates as a result. Yet for all that, it may simply be that China is doing what both the IMF and Washington have been calling for it to do for years.

China wants its currency, the yuan, or the renminbi, to be part of the basket of currencies that make-up the IMF’s Special Drawing Rights, or SDR. For this to happen, the IMF says that the yuan must be allowed to trade freely on the open markets. China say that this is precisely what it is doing.

There was a time when China manipulated its currency, keeping its value artificially low. To achieve this, the government went out and bought western bonds, especially US government bonds. This in turn pushed up on the value of those bonds, causing their yields to fall. It’s an important point that often gets overlooked. Some criticise the Fed’s polices over the years, but truth be told in the long term, it is not central banks which determine interest rates, but movements of money which in turn can be changed by deep forces at play. China’s policy of maintaining a cheap currency was a major factor in creating low interest rates for much of this century. And while the cheap yuan theoretically led to lower US exports, US borrowing was partly funded by China, and at exceptionally low interest rates.

It is just that the yuan is no longer cheap. It hasn’t been for some time. If the yuan really was allowed to trade freely, it would surely fall in value. Washington can scream with fury, but China is gradually moving towards a position that the US has wanted it to occupy for years.

After the first devaluation, the IMF said “The new mechanism for determining the central parity of the Renminbi announced by the PBC appears a welcome step as it should allow market forces to have a greater role in determining the exchange rate. The exact impact will depend on how the new mechanism is implemented in practice. Greater exchange rate flexibility is important for China as it strives to give market-forces a decisive role in the economy and is rapidly integrating into global financial markets. We believe that China can, and should, aim to achieve an effectively floating exchange rate system within two to three years. Regarding the ongoing review of the IMF’s SDR basket, the announced change has no direct implications for the criteria used in determining the composition of the basket. Nevertheless, a more market-determined exchange rate would facilitate SDR operations in case the Renminbi were included in the currency basket going forward.”

Some say the timing is cynical, because China has devalued in the same week that saw weak data on industrial production investment and retail sales. That may be right, but so what. China is simply doing what the IMF has recommended, but chosen the most fortuitous moment. What’s wrong with that?

Oil has fallen again in recent weeks. This week, West Texas Intermediate oil has been hovering at just a dollar or two above the year low. Meanwhile, a report from the National Institute of Economics and Social Research (NIESR) has predicted that 2015 will be the worst year for the global economy since 2008. It shouldn’t be like that. With oil as cheap as it is, the economy should be booming. So this all begs the question, “why?” Is there some rather worrying underlying reason for the weakness in the global economy?

At the time of writing (6 August 2015, 6.45 am) West Texas Intermediate oil is trading at $45.17. To put that in context, just over a year ago it was trading at $104. Brent crude oil is just shy of $50. One day, black gold will probably go back over $100. Maybe, one day it will even pass the 2008 peak, when it went close to $150, but this day is not likely to be any time soon. The oil cycle moves slowly. Investment in oil has dropped drastically, new projects have been shelved. It will be several years before these developments show up in rising oil prices, though.

There are winners and losers from cheaper oil. Apologies if this sounds like a lesson from the University of the Bleeding Obvious, but cheaper oil benefits its consumers and hits its producers. So in theory the effect of falling oil prices on the global economy should be neutral. It is just that on the whole, oil consumers have a much lower savings ratio that oil producers. A fall in the oil price distributes income from high savers to high spenders. Given that we are in a time when there is a chronic shortage of demand worldwide, this should be good news.

As an aside, there is another not commonly understood potential side effect of cheaper oil. Ask yourself this question, why are interest rates so low? That is to say, what is the real reason? Forget central bankers, they move with the tide. The main reason why rates are so low is because worldwide there is a shortage of demand and a savings glut. Back in the noughties this savings glut funded consumer spending in the West, creating a bubble which burst in 2008. Since then it has been funding surging government debt, and maybe sharp rises in debt in emerging markets. McKinsey has said that global debt has risen by $57 trillion since 2007. The savings glut made this possible. There are many reason for this, and many of these reasons have not gone away. But at least one driver of low interest rates, the rise in savings coming out of oil producers, has gone into reverse.

Returning to the global economy in 2015, earlier this week NIESR projected that “The world economy will grow by 3 per cent in 2015 – the slowest rate since the crisis – and 3.5 per cent in 2016.” So that is odd. The price of oil has fallen by a half, and the global economy is weak. Something is wrong.

There are two ways looking at this. You can look at individual countries, one at a time, or you can look for some deeper underlying cause.

The US has a bad start to the year because of an exceptionally cold winter in the north east of the country. This had a knock-on effect worldwide. The UK, it appears, got caught up in it all with falling exports to the US dragging down on growth.

By its standards, the Eurozone had a good first half of this year, this despite Greek woe. But then again, this is the Eurozone, and the key phrase here is “by its standards.” The only other region in the world that puts in such a continuously poor performance is Japan.

The world’s second largest economy, China, has slowed fast. There is more than one reason. For one thing, China sits on a mounting debt pile, with local government especially badly exposed. This is beginning to hurt. For another thing, the Chinese government is trying to re-engineer the shape of the Chinese economy, shifting it from investment and savings led, to consumption led. This is a good thing, but the transformation is hurting

Russia’s problem are well documented. It is clear that it has lost out big time to the falling oil price. Brazil has suffered from a wider fall in commodity prices, but like Russia, there were deep structural problems with the economy anyway.

So pick it apart, there is a reason for the slow growth. Even so, I can’t help but feel that the overall performance of the global economy, given how weak oil and other commodity prices are, is very disappointing. You could respond by saying that I have mixed up cause and effect. You could say that oil has fallen in price because global demand is low. But I would respond to that by saying at least part of the reason for the fall in the oil price has been the revolution in fracking and previous surges in oil investment. The rise of renewables are taking a toll, too. I don’t accept that I have got things the wrong way round.

So what are the possible underlying drivers at work? There are to theories to explain what is happening, there is the Robert Gordon ‘innovation is slowing’ theory, and the Larry Summers Secular Stagnation theory. I will look at these theories in more depth in a few days.

When was the last time you had a pay rise? Many people might answer that question by saying “about five years ago.” Envy the Chinese, or Poles, or Mexicans, or Indians. According to PwC, they are likely to see their wages shoot up. This is set to be a very important development, with implications for investors and businesses seeking new opportunities. But maybe workers in the west don’t need to be too envious, the pay gap will still be pretty enormous. It’s a very important trend all the same.

Between now (2013) and 2030, real wages in the US and the UK are expected to rise by about a third. Let’s hope that’s right – relative to what we have seen over the last half decade that would be a result. But over that same time frame, average wages in India could more than quadruple in real dollar terms and more than triple in the Philippines and China.

Let this chart do the talking:

So what are the implications? First of all see the expected rise in wages across these countries in the context of re-shoring. See: Is manufacturing coming home? It will clearly provide the impetus for companies re-shoring their manufacturing closer to where most of their customers are.

What we may see, as wages rise in China, is not only more manufacturing in home territories, but nearby too. Opportunity, as they say, knocks for Poland and Mexico.

Looking further ahead, PwC says places such as Turkey, Poland, China, and Mexico will therefore become more valuable as consumer markets, while low cost production could shift to other locations such as the Philippines. India could also gain from this shift, but only if it improves its infrastructure and female education levels and cuts red tape.

From a corporate/investment point of view, who will be the winners and losers? PwC reckons western companies who may emerge as winners will include retailers with strong franchise models, global brand owners, business and financial services, creative industries, healthcare and education providers, and niche high value added manufacturers.

As for losers: well, watch mass market manufacturers, financial services companies exposed in their domestic markets, and for companies that over-commit to emerging markets without the right local partners and business strategies.

Re-shoring. If the last decade or so has been characterised by off-shoring, then maybe we are set to enter a new era in which manufacturing returns to home markets, or, failing that, to countries much closer to home. Re-shoring: if it proves to be real, it may provide real, underlying strength to economic recovery. If it proves to be real, then real hope can be added to economic commentary; hope that this time recovery can last. And now we have evidence that it may indeed be happening, right now.

Sometimes predictions can become descriptions. You can forecast what the weather is going to be like. It is much easier and more credible, although perhaps less interesting, to describe what the weather is like. But Boston Consulting has moved from forecaster to describer in one very crucial area. A couple of years ago it made headlines for forecasting a new trend in manufacturing, as companies opt to make their products nearer to their home markets. Now it reckons it has evidence that this is actually happening.

Being one of the world’s largest consultancies, Boston Consulting’s surveys tend to be pretty meaningful. It asked executives at US companies with sales greater than $1 billion about their manufacturing plans. A year ago, 37 per cent said they “are planning to bring back production to the US from China or are actively considering it.” In its latest survey, the results of which were published this week, that ratio rose to 54 per cent.

So why, oh why? 43 per cent of respondents cited labour costs; 35 per cent proximity to customers; and 34 per cent product gave quality as their reason for considering re-shoring.

Michael Zinser, from the consultancy, said: “Companies are becoming more sophisticated in their understanding of all the factors that must be considered when deciding where to manufacture…When you look at the total cost of production for many goods, the US appears increasingly attractive.”

The Boston Consulting survey probably provides the most compelling evidence to date that re-shoring is occurring, but it is far from being the only evidence.

Back in July a survey from YouGov on behalf of Business Birmingham revealed that one in three companies that currently use overseas suppliers are planning to source more products in the UK. John Lewis recently said that it plans to increase the volume of made in the UK products by 15 per cent between now and 2015.

This development is good news in more ways than one; it may even be very good news in quite a profound way, but more of that in a moment.

But what about China? This is surely not such an encouraging development for the economy behind the Great Wall. Well maybe it isn’t, but maybe it actually is. What China needs is for wages to rise, and for it to see more growth on the back of rising demand. Its economy is simply out of balance. No one is predicting the end of Chinese manufacturing, merely that it may lose some of its dominance. If this loss occurs because wages in China have risen, creating more demand, this is good news for China, its suppliers and the companies that sell to its consumers. Okay, changes are never smooth. There will be short-term headaches caused by re-shoring, but the overall impact will be positive rather than negative.

But there is another perhaps more important implication.

Over the last few decades we have seen growing inequality, and company profits taking up a higher proportion of GDP, while wages take up a lower proportion. Some think this is good thing, and accuse those who criticise of being guilty of the politics of envy. They miss the point. You may or may not think inequality is morally justified, but it is clear that from an economic point of view it is inefficient. For an economy to grow it needs demand to rise, and in the long run this can only occur if the fruits of growth trickle down into wage packets. It is perhaps no coincidence that the golden age of economic growth occurred in the 25 years after the end of World War II, an era which saw much more equality than we see today.

It is possible that re-shoring is symptomatic of changes in the balance of power across the markets. For years we have seen what the IMF calls the globalisation of labour: the reward to capital rose, the reward to labour fell. The underlying cause of this may have been the one-off effect of millions of Chinese workers joining the globalised economy. As this one-off effect begins to ebb, we may see the globalisation of labour work in reverse.

There are almost as many opinions as there are Chinese. Some say the Chinese growth miracle is at an end. Others see a temporary lull. Others still, point to demographics and see problems ahead. Yet others say we are confusing western culture with that of China; that it is unstoppable. Some go even further and say that China – via its system of central control – has been deliberately manipulating a system and it will soon reign supreme over the global economy. Or to put it another way: some say ‘this time it is different’, and although China portrays many of the hallmarks of a bubble, it is just different from the West, while others say the claim that ‘this time it is different’ is always – and without fail – a sign that things are set to come very badly unstuck.

You may have picked up on the irony. After 1989, the consensus seemed to be that capitalism had won; that any system of central control was doomed to fail. Now there seems to be a view held by many that China is unstoppable precisely because it has so much central control that its state can force through reforms and regulations that western governments can only dream of.

This view is almost certainly wrong. For one thing, to argue that China is unstoppable because of its central control appears to be ignoring the lesson of the history of the last half of the 20th century. For another thing, it is debatable how much power the Chinese government really has. China is a massively complex country, and while Beijing may issue directives on how things must be done, the extent to which they are followed across the country is open to debate. In any case, China’s government is terrified of social discontent. For the country’s government there is always the fear of how the people will react if the government mismanages the economy.

This fear of popular discontent can often stop the government from doing precisely the things it should do for longer term prosperity. Take as an example its policy regarding its currency – the yuan. The US government is screaming at China to let the yuan trade freely. Many US politicians blame a cheap yuan on just about all of the US ills. They are surely wrong, but there is no doubt that if the yuan were to rise, US exporters would benefit, but how much is open to debate? But what people often overlook is that there is very strong evidence to suggest that China too needs a more expensive currency.

A consequence of China’s currency policy has been too low interest rates, which has all kinds of undesirable consequences – among them a credit bubble, too much emphasis on investment, and there appears to be evidence that low interest rates have led to Chinese companies paying out lower dividends, which has helped to accentuate imbalances in the economy.

Part of China’s problems can be dated back to 2008, when the West hit the crisis button. China responded with a massive stimulus of its own. It kept growing during the worst days of 2008 and 2009 but at what cost? According to the IMF, in 2008 China’s money supply jumped 30 per cent – and that is ironic. While China was accusing the West of debasing its currencies via QE, and lecturing the US on living within its means, China began to apply the kind of policies that got the West into its mess in the first place.

Then there is credit. In 2008 total outstanding credit in China was 130 per cent of GDP – a level that had pretty much been unchanged for several years. Now the ratio is at 187 per cent – that was a massive hike for just half a decade. The IMF has said that when a country sees credit increase by 3 per cent of GDP or more in a year, there is a good chance that a crisis may follow. Yet In China the rate of credit growth dwarfs what the IMF might refer to as the danger level.

For China corporate sector debt is the real danger. This has risen from just over 20 trillion yuan in 2007 to over 60 trillion in 2012.

This may all sound like western cynicism, but just remember it was the man who until last year was China’s premier – Wen Jiabao – who described China’s economy as, “unstable, unbalanced, uncoordinated, and unsustainable.”

It is not all woe, however. Recent anecdotal evidence such as the latest Purchasing Managers’ Indices, and data on freight transport, electricity output and volume of cargo all point to China’s economy seeing a mild pick-up. It is not going to see growth in excess of 10 per cent again for a while – if ever – but the recent data is consistent with growth of around 7.5 per cent, which is much better than many had warned.

The pick-up may be occurring because once again China is implementing short-term policies to push up growth via the very things that it has too much of anyway – namely investment, government spending, credit. But with signs that the US economy is at last on the mend, it may be possible for China to tighten up monetary policy allowing the yuan to rise, without taking too big a hit on exports.

Looking further forward, what China really needs is higher wages. Well this is happening. McKinsey has forecast that by 2022, 75 per cent of China’s urban workers will earn between $9,000 and $34,000 – a level that sits half way between current levels in Italy and Brazil. To put this figure in context, in 2000 just 4 per cent of Chinese urban workers had earnings falling within that band. McKinsey also forecasts that by 2022 urban income will double from current levels. These are precisely the developments China needs.

Then there is education. The OECD measures pupil skills in reading, numeracy and science, in a test known as PISA. The BBC recently quoted Andreas Schleicher, a leading figure behind these PISA tests, saying there are signs that China is closing – if it has not already closed – the education gap with the West. Shanghai has excelled, but said Mr Schleicher: “What surprised me were the results from poor provinces that came out really well. The levels of resilience are just incredible.” He said that he gets the impression China is investing in the future. Unlike the US, there are indications of a high degree of education equally between rich and poor.

China’s next big challenge is how it can manage being a middle income country. Over the last half a century only a handful of countries managed that transition. Many saw rapid growth, but then stopped before income levels had reached anything like western levels. Will China be one of those rare successes?

It does have one major hurdle to climb, however, and that is demographics. According to the UN, the population of China aged between 15 and 59 is set to fall by 7 per cent between 2010 and 2030. The policy of one child per family is about to be relaxed, but even so, many Chinese couples don’t want more than one child. In any case, even if the birth rate shot up overnight, it would take the best part of two decades before this showed up in the work force.

Associated with demographics is the question of the so-called Lewis Turning Point – a point familiar to economists – when a country runs out of workers to migrate into urban areas.

Let’s finish with what the IMF says on this subject: “Within a few years the working age population will reach a historical peak, and will then begin a precipitous decline. The core of the working age population, those aged 20–39 years, has already begun to shrink. With this, the vast supply of low-cost workers—a core engine of China’s growth model—will dissipate, with potentially far-reaching implications domestically and externally. The reserve of unemployed and underemployed workers (which is currently in the range of 150 million)—will fall to about 30 million by 2020 and the LTP [Lewis Turning Point] will be crossed between 2020 and 2025.”

You may have heard of Solomon Asch. He was the psychologist who helped to introduce us to the idea of group compliance. In his famous experiment, subjects were handed two pieces of paper. On one was drawn a line; on the other three lines. One of the lines on the second sheet was the same length as the line on the first; the other two lines were obviously different.

Subjects were asked to identify which line on the second sheet was the same length as the line on the first. It was an easy test, and nearly all subjects got it right.

Then he played a trick on them. Subjects were put into a group situation. Unknown to them, the rest of the group were actors, and each actor deliberately pointed to the wrong line. It is not hard to imagine how the subjects reacted; their sense of panic or of self-doubt. In fact, in the original Asch experiment no less 74 per cent of those who took part complied with the group, getting the obvious right answer wrong on at least one occasion.

The Asch experiment illustrates how bubbles, even wars, can occur, as individuals comply with the crowd. It is interesting to note, however, that if one actor goes against the rest, and guesses correctly – or perhaps wrongly but with a different wrong answer from everyone else – the subject was far more likely to go against the crowd. It does not take much to break crowd compliance.

The Asch experiment has been repeated worldwide, and it was found that group compliance tended to be slightly higher in countries seen as having a more cooperative and less individualistic culture, such as China. Now don’t over-egg this one. The difference is not that great, but it does go to show that – contrary to what some argue when they say China is different – there are reasons to think China is just as susceptible to bubbles as the rest of us.

Is it for real? We keep hearing talk of an export-led recovery for the UK. But is it simply that the UK exports are so low that any rise looks to be quite significant in percentage terms. A new report from Ernst and Young provides just a hint that this time it might be for real.

UK companies need to look abroad. The last few years have seen UK consumers cutting back, and that, suggests Ernst and Young, is why they have been focusing on ways to increase exports.

The story overall? Well, let’s return to that in a moment. Let’s start with the positive.

According to Ernst and Young, the West Midlands “is emerging as an export powerhouse” and “is on track to grow goods exports faster than any other UK region by selling high-end engineering far outside Europe.” Engineering goods exports are forecast to grow at “an annualised rate of 4.8 per cent, worth £6.9 billion in 2017, compared with £5.5 billion in 2012.”

UK automotive exports to China are expected to grow 11.6 per cent – making it the UK’s top automotive trading partner by 2017, while exports of personal vehicles to Thailand are expected to rise from $302 million in 2012, to $617 million by 2017. The UK is expected to capture a 53 per cent share of the entire import market. UK engineering is also seeing exports rise to the Middle East – with growth in turbo jet exports to Qatar alone forecast to grow from $273 million in 2012 to $481 million in 2017. And finally, UK biopharma exports to China are expected to double from $52 million in 2012 to $104 million by 2017, with Chinese biopharma imports set to rise to $2.5 billion by 2017 (from $1.4 billion in 2012).

Break it down bit further, and Ernst and Young forecasts that in 2017, UK engineering exports to China will be worth $2.4 billion, automobile exports $3.8 billion and metals $2.1 billion. For Brazil, it forecasts $0.7 billion for engineering, $0.6 billion for automobiles and $0.6 billion for chemicals. For Hong Kong it forecasts engineering exports of $1.7 billion, $1.4 billion for electronics, and $1.3 billion for previous metals. And for Saudi Arabia it forecasts engineering exports of $0.9 billion, $0.4 for electronics and $0.4 for pharmaceuticals.

And yet for all that, Ernst and Young says that across the UK exports are not growing fast enough. It forecast 0.3 per cent annual growth for UK good exports against 1 per cent for the European average between now and 2017. So for the conclusion: making progress, but could do better.